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Heterogeneous Expectations, International Consumption Correlations, and Common Risk Factors in World Stock Markets

Galsb, Victoria; Hoffmann, Mathias (2008). Heterogeneous Expectations, International Consumption Correlations, and Common Risk Factors in World Stock Markets. Working paper series / Institute for Empirical Research in Economics No. 362, University of Zurich.

Abstract

This paper establishes a surprising and robust empirical similarity between short-run heterogeneous consumption and long-term consumption growth risk models. The models not only deliver a similar fit on a given set of portfolios, their actual pricing errors are also highly correlated. In addition, we find that consumption dispersion is a robust predictor of the transitory component in aggregate consumption growth. To interpret these findings, we propose a model in which aggregate uncertainty is a function of idiosyncratic uncertainty and only long-term consumption growth risknis priced. An implication of this being that consumption dispersion is priced empirically not because markets are necessarily incomplete but because investors disagree in the short-run about theirncommon long-term consumption prospects.

Abstract

This paper establishes a surprising and robust empirical similarity between short-run heterogeneous consumption and long-term consumption growth risk models. The models not only deliver a similar fit on a given set of portfolios, their actual pricing errors are also highly correlated. In addition, we find that consumption dispersion is a robust predictor of the transitory component in aggregate consumption growth. To interpret these findings, we propose a model in which aggregate uncertainty is a function of idiosyncratic uncertainty and only long-term consumption growth risknis priced. An implication of this being that consumption dispersion is priced empirically not because markets are necessarily incomplete but because investors disagree in the short-run about theirncommon long-term consumption prospects.

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